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Oversight of Cross-Border Funds Distribution: The Assurance and Benefits Provided by an Effective

AML and CTF Audit

Giovanni Frau, CAMS

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Table of contents

1. Executive summary

1.1 Regulatory pressure and the international dimension

1.2 Complexity of investment funds distribution

1.3 Oversight methodology

1.4 Objective of this whitepaper

2. Luxembourg investment funds industry

2.1 Vulnerabilities of funds

3. The Luxembourg regulatory framework 3.1 Regulator

3.2 AML/CFT regulations

4. Cross-border fund distribution 4.1 Risk assessment

4.2 Example of a country risk: Taiwan

4.3 On-site visits to the distributors

4.4 Cross-border distribution through platforms 4.5 Cross-border distribution through Fintech

5. AML/CFT Audit Program 6. Benefits of an AML Audit

References Glossary of acronyms

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1. Executive summary

1.1 Regulatory Pressure and the International Dimension

Anti-money laundering (AML) tops the agenda for senior managers and boards of directors of Luxembourg investment funds. Regulatory pressure to comply with AML and counter-terrorist financing (CTF) has increased globally. In Europe, more banks and financial institutions have been facing the prospect of multi-million Euro penalties for breaches of AML/CTF regulations than ever before. Increasingly, regulators are requiring the completion of annual ad-hoc AML/CTF reports. In addition, they are requiring that the reports be submitted to senior management and be made available to regulators during on-site visits. Recent AML scandals, such as Malaysia’s 1MDB Fund and its consequences to the Singapore branches of some Swiss private banks,1 as well as to their respective headquarters, show that the consequences of money laundering (ML) breaches are not limited to a well-defined geographical area, but can have a wider international dimension.

The Financial Action Task Force (FATF) Recommendations, the Basel paper “Sound Management of Risks Related to Money Laundering and Financing of Terrorism,” IAIS Guidance Paper 5 and the IOSCO Principles paper encouraging national supervisors of financial firms to follow specific due diligence procedures in relation to customers2 also evidence the international dimension to the effort to curb money laundering.

1.2 Complexity of Investment Funds Distribution

AML compliance is particularly complex when it relates to the distribution of investment funds and specifically where management companies rely on third parties in their distribution network. The complexity increases when the distribution network is worldwide with distributors based outside the jurisdiction of the investment fund promoters.

The Grand-Duchy of Luxembourg (“Luxembourg”) is a primary domicile for the establishment of management companies, which then market investment funds all over the world through an international distribution network. This international presence increases AML/CTF compliance challenges. These challenges can be managed by the establishment of an effective oversight regime over the distribution network. In practice, the complexity of implementing a strong oversight regime over Luxembourg investment funds’ distribution networks arises from the cross border nature of the Luxembourg investment funds industry.

1.3 Oversight methodology

The oversight methodology needs to consider the existence of different distribution models and geographies, incorporating different AML/CTF regulatory regimes with different regulators to which the distributors are accountable. The oversight methodology will need to consider whether the distribution is through captive and/or non-captive channels. Clearly, captive channels will imply common policies, common processes and a common culture, reflecting the holding company’s regulatory regime and these factors will facilitate oversight. Non-captive channels will involve multiple independent distributors with different policies, processes and procedures, which must be understood and will make the analysis more challenging. Furthermore, the complexity will be increased if the distributors are financial entities or platforms and if they operate, and distribute the funds in different geographical locations. For instance, a branch of a U.S. bank operating in a high-risk country might eventually require a different level of oversight compared to a bank based and operating in a high-risk country.

1.4 Objective of this White Paper

1 Financial Times – Singapore shuts second Swiss bank over 1MDB corruption scandal, available at: https://www.ft.com/content/ec182626-8f64-11e6-a72e-b428cb934b78 2 Joint Money Laundering Steering Group Guidance –JMLSG – Prevention of money laundering / combating terrorist financing (Chapter I),

November 2014 available at: http://www.jmlsg.org.uk/

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This white paper intends to prove that an effective AML/CTF audit can represent a competitive advantage for management companies distributing funds worldwide. It will show how a pragmatic methodology for the implementation of oversight can provide assurance and benefits to senior management, who will bear the ultimate responsibility in the event of a breach of AML/CTF regulations. The white paper will focus on the investment industry in Luxembourg, its regulatory framework and the complexity of cross border distribution models.

2. Luxembourg Investment Funds Industry

The investment funds industry in Luxembourg has developed successfully and today Luxembourg is the leading investment fund center in Europe. The Association for the Luxembourg Funds Industry (ALFI) reported 3,741.33 billion euros of assets under management as of December 31, 2016—an annual growth of 6.7 percent. Luxembourg is well known as a Undertakings for Collective Investment in Transferable Securities (UCITS) fund hub. However since the introduction of the Alternative Investment Fund Managers Directive (AIFMD), ALFI has seen increasing interest and activity from asset managers of private equity, real estate and hedge funds.

Luxembourg has been able to turn retail funds into a global brand, by specializing in the administration and cross-border fund distribution of investment funds. In the context of UCITS funds, Luxembourg has taken advantage of the opportunities given by the passport regime and consequently, has become the leading jurisdiction in the world for retail cross-border distribution. Luxembourg is building on this positive experience and offers the opportunity for both AIFMs and AIFs to use Luxembourg as a hub for marketing AIFs to professional investors in the EU and, potentially (as is currently the case for UCITS) beyond.3 It has become a platform of choice for promoters willing to distribute their funds across the border.

The most common form of alternative funds are private equity and real estate funds (PE/RE). While PE/RE have an intrinsic AML/CTF risk in the assets they target, requiring a careful due diligence to identify any suspicious investment pattern in assets, retail funds have an additional layer of complexity because they are distributed through a third-party distribution network. The distribution channel and the jurisdiction it operates in can potentially cause AML/CTF oversight issues. This requires promoters to avoid a silo approach to the oversight of money laundering and terrorist financing risks. It is crucial to assess the relationship between customers, products, channels, geography and employees. Controls that are built to relieve compliance burdens on lower risk money laundering/terrorist financing products, channels, countries and employees, may be abused by customers that pose a higher risk from a money laundering/terrorist financing perspective.

2.1 Vulnerabilities of Funds

The money launderer’s objective is to confer on the proceeds of their crimes a legitimate appearance. Mutual funds may present opportunities for abuse by money launderers. Intermediaries could be misused to gain access to a correspondent account through a power of attorney, so the fund would have to have access to the underlying customer due diligence. The fund could prevent money laundering by refusing such a direct relationship. Non-face-to-face-relationships may attract money launderers who wish to conceal the proceeds of their crimes by hiding behind a false or stolen identity.4 Refusing to accept or make third-party payments would prevent this. For AML purposes, this measure would be effective because it will significantly decrease the possibility of this type of money laundering occurring. In general, mutual funds are perceived to entail a lower risk of money laundering for a number of reasons, including:

Assets typically flow into pool vehicles (PVs) from (and interests in PVs are typically distributed by) other financial institutions which are themselves regulated for AML purposes. This reduces the risk of a PV being involved in money laundering activities;

3 ALFI web-site, www.alfi.lu 4 Joint Money Laundering Steering Group Guidance –JMLSG – Prevention of money laundering / combating terrorist financing (Chapter II),

November 2014 available at: http://www.jmlsg.org.uk/

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Many PVs have measures and controls in place that make them less attractive for money laundering purposes, such as restrictions on cash withdrawals from, or on transactions with, parties other than the investor;

PVs are commonly used for long-term investment purposes (and some may have minimum investment periods and/or weighted fee structures) making high turnover or short-term investment unattractive and/or unusual.

However, because of the sheer size of the PV industry, the ready accessibility of PVs to investors, and the ease with which money launderers can simulate the behavior of a legitimate investor, it is possible that PVs will be used by criminals and terrorists laundering the proceeds of their crimes in a manner that may be extremely difficult (and at times impossible) to detect.5

3. The Luxembourg Regulatory Framework

3.1 Regulator

The regulator in Luxembourg is the Commission de Surveillance du Secteur Financier (CSSF), which is a public institution that supervises the professionals and products of the Luxembourg financial sector. It supervises, regulates, authorizes, informs, and, where appropriate, carries out onsite inspections and issues sanctions.6 The CSSF is responsible for the prudential supervision of inter alia credit institutions, professionals of the financial sector, alternative investment fund managers, undertakings for collective investment, pension funds. The CSSF’s objectives are to:

Promote a considered and prudent business policy in compliance with the regulatory requirements;

Protect the financial stability of the supervised companies and of the financial sector as a whole;

Supervise the quality of the organization and internal control systems;

Strengthen the quality of risk management.

The CSSF is responsible for ensuring compliance with professional obligations in regards to the fight against money laundering and terrorist financing by all the persons subject to its supervision.7 It has a wide range of powers at its disposal to perform this mission. It also has the power to impose sanctions on those persons subject to its supervision that violate the regulations relating to AML or on those that do not comply with the professional obligations imposed upon them.8 The Law of March 15, 2016 specifies that the CSSF may issue sanctions ranked in order of gravity including: warnings, reprimand, an administrative fine of between 250 and 250,000 euros, a temporary or definitive ban from performing one or more operations, or all of its activities.

3.2 AML/CFT Regulations

When funds are distributed globally through a third-party distribution network, the distribution channel and the jurisdiction(s) it operates in need to be carefully assessed from an AML/CTF risk perspective. It should be noted that there are an array of AML/CTF laws, regulations and circulars applying to investment funds. For cross-border distribution, the CSSF Regulation 12-02 of December

5 Wolfsberg Statement – Anti-Money Laundering Guidance for Mutual Fund and Other Pooled Investment Vehicles, available at: http://www.wolfsberg-principles.com/pdf/standards/Wolfsberg_PV_Guidance_(2006).pdf 6 www.cssf.lu 7 www.cssf.lu 8 www.cssf.lu

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14, 20129 on AML/CFT, provides a clear set of rules and principles, which management companies and funds must apply consistently in order to manage the inherent risks posed by cross-border fund distribution.

A fund may be established as a contractual fund or an investment company. The AML/CTF controls are performed by a management company, the board of which has ultimate responsibility for its AML/CTF oversight regime, together with the board of the fund (for investment companies). The laws regulating retail and alternative funds provide rules in terms of organization, management and oversight. In particular, they require management companies of funds to establish appropriate internal controls, which is a critical requirement of the Luxembourg AML/CTF Regulations.10 The ALFI Guidelines provide practices and recommendations for the due diligence measures to be applied to investors and intermediaries in foreign jurisdictions, in compliance with other international standards, including the FATF recommendations as well as the European Directive 2005/60/EC and 2006/70/EC, on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing. They also comply with the Wolfsberg Statement on “Anti-Money Laundering Guidance for Mutual Funds and Other Pooled Investment Vehicles.” The extent to which UCIs and professionals in the fund industry follow these practices and recommendations is the responsibility of their respective governance bodies.11

Article 3 of the CSSF 12 -02 Regulation12 specifies that where the units or shares of an undertaking for collective investment, or an investment company in risk capital are subscribed to through an intermediary acting on behalf of its customers, the undertaking for collective investment, its management company, the investment company in risk capital or, where applicable, the respective proxy of the professionals, must establish enhanced customer due diligence measures for this intermediary. These measures are applied mutatis mutandis pursuant to the terms of Article 3-2(3) of the 2004 law, Article 3(3) of the Grand-ducal regulation and Article 28 of CSSF 12-02 regulation. Funds are required to appreciate the risk profile of their distributor network, customer type and geographical locations. This may be achieved by reviewing the distributors’ country risk profile and AML/CTF standards there, as well as—by means of periodic reporting received from the distributors—the level of AML/CTF compliance controls applied by them. Underlying investor information should also made readily accessible to the management company upon request.

The law does not provide a definition or example of a higher risk distribution channel. Each fund has to determine the risks inherent to a particular distribution channel, by considering the risk profile of the parties involved in that distribution channel (i.e., the level of AML and CTF controls they apply, as well as the level of supervision they are subject to and the distribution country’s risk profile). The transparency of the distribution channel, the nature of the business and source of the funds, and the UCI/Promoter’s ability to monitor and obtain additional information about the business conducted through the distribution channel must also be considered. 13

Funds are required to exercise oversight of the distributors by ongoing monitoring and periodically conducting an appropriate onsite AML audit during which data and documentation from those underlying clients that are based in countries that have significant level of criminality and/or significant political instability, making them attractive to money launderers and/or terrorist organisations, must be provided.

9 CSSF Regulation 12-02 available at http://www.cssf.lu/fileadmin/files/Lois_reglements/Legislation/RG_CSSF/RCSSF_No12-02eng.pdf 10 Law of 17 December 2010 on undertaking for collective investments 11 ALFI Guidelines, Practices and Recommendation aimed at reducing the risk of money laundering and terrorist financing in the Luxembourg Fund Industry, available at: http://www.alfi.lu/sites/alfi.lu/files/files/Alfi%20guidelines%20and%20recommendations/Guidelines-ABBL-ALCO-ALRIM-final.pdf

12 CSSF Regulation N 12-02, available at: http://www.cssf.lu/en/supervision/financial-crime/aml-ctf/laws-regula tions-and-other-texts/news-cat/480/ 13 ALFI Guidelines, Practices and Recommendation aimed at reducing the risk of money laundering and terrorist financing in the Luxembourg Fund Industry, available at: http://www.alfi.lu/sites/alfi.lu/files/files/Alfi%20guidelines%20and%20recommendations/Guidelines-ABBL-ALCO-ALRIM-final.pdf

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4. Cross-border Fund Distribution

Fund distribution is now facing increased regulation. Successful promoters are those who possess a distribution network that is subject to a rigorous and effective AML oversight regime. Funds depend significantly on the distribution channel through which they gather their assets under management. Distribution oversight is generally performed by implementing AML/KYC oversight requirements over end investors. The assessment of the distribution network itself can be overlooked or even neglected.14 Consequently initial and ongoing due diligence of distributors is of paramount importance. Therefore, it is vital for funds to establish appropriate measures to manage AML/CTF risks and ensure that the distribution network creates revenues without the potential risk of causing damage to the business. CSSF Circular 12/546 dated October 24, 201215 requires a management company to monitor its delegates (including distributors) on an ongoing basis. The regulator requires promoters to understand how and by whom their products are sold. This is particularly challenging when the products are sold cross-border in multiple jurisdictions by distributors subject to different AML/CTF regulatory systems.

Although promoters may appoint global distributors which will deal with the initial and ongoing due diligence, the ultimate responsibility for all delegated activities will always remain with the board of directors of the management company. Defining a robust, flexible and efficient process for distribution oversight will provide comfort to the board of directors, effectively support the business, ensure compliance with the regulatory environment and manage risk.

Distribution oversight may be a time-consuming administrative task,16 especially within the context of UCITS cross-border fund distribution. But it is nevertheless essential. To be effective the distribution oversight needs to apply a risk-based approach to the due diligence undertaken. It is arguable that prima facie there is not the same perception of risk if the funds are distributed by a large and well established EU or U.S. banking group compared to a small distributor in a non-equivalent country. The risk appreciation will still also differ in the case of cross-border distribution through master feeder structures. Due to marketing limitations in certain markets, such as Thailand or Brazil, promoters may decide to seek a local partnership in order to launch an ad hoc local retail fund (feeder), which will then invest all its assets into a master fund, which would be a fund established in Luxembourg. Normally the register of the Luxembourg fund will have a nominee position in the feeder fund, which should be appropriately overseen by the Luxembourg management company, to avoid any AML/CTF consequences, including potential reputational damage for the Luxembourg fund.

4.1 Risk assessment

The FATF recommendations have recognized the principle of a risk-based approach (RBA) to combating money laundering and terrorist financing (ML/TF). The FATF recommends that countries should identify, assess, and understand the ML and TF risks for the country and should require financial institutions to identify, assess and take effective action to mitigate their money laundering and terrorist financing risks. Chapter 3 of the CSSF 12-02 Regulation has strengthened the concept of an RBA, introduced by Article 3(3) of the law of November 12, 2004 on the fight against money laundering and terrorist financing, the requirements of which were subsequently specified by CSSF Circular 11/529 relating to risk analysis regarding the fight against money laundering and terrorist financing. The RBA uses the concepts of simplified customer due diligence, standard customer due diligence and enhanced customer due diligence. Article 5 of the CSSF 12-02 Regulation states that the risk level shall

14 Mastering the distribution chain and related operational changes, Deloitte publications, available at: https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/financial-services/IM/lu-mastering-distribution-chain-operational-challenges.pdf 15 CSSF Circular 12/546 available at:

http://www.cssf.lu/fileadmin/files/Lois_reglements/Circulaires/Hors_blanchiment_terrorisme/cssf12_546eng_upd291215.pdf 16 Mastering the distribution chain and related operational changes, Deloitte publications, available at: https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/financial-services/IM/lu-mastering-distribution-chain-operational-challenges.pdf

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be assessed according to a consistent combination of risk factors defined by each professional, according to the activity exercised and inherent to the following risk categories: customers, countries or geographic areas, products, services, transactions or delivery channels and marketing arrangements. To comply with the regulation, promoters need to establish an AML/CTF country risk assessment which will establish whether a specific country is low, medium or high risk on the basis different risk factors including: FATF membership, Mutual Evaluation Report conclusion as well as follow-up, corruption perception risk, BASEL AML Index Report, U.S., UN and EU sanctions, etc. Since the issuance of CSSF Circular 17/650, an additional factor to consider would be whether the country has implemented the automatic exchange of information or Common Reporting Standard (CRS). CSSF Circular 17/650 has been issued jointly by the CSSF and the Luxembourg Financial Intelligence Unit, it relates to the extension of the offense of money laundering to aggravated tax fraud and tax deceit. CSSF Circular 17/650 is an early enactment of certain provisions of the Fourth EU AML Directive.17

The AML/CTF country risk assessment enables promoters to differentiate between those countries that have equivalent AML/CTF standards to those of Luxembourg and those that do not. Equivalent AML obligations are those that comply with the Luxembourg AML/CTF regulatory framework. Generally, distributors based in EU are deemed equivalent while those based outside the EU are individually evaluated based on a risk profile that refers to the specifications of the FATF and CSSF Circulars, and those of other bodies.

4.2 Example of a Country Risk: Taiwan

However, any qualitative assessment implies some subjectivity. A risk assessment for Taiwan demonstrates this subjective element. Taiwan is a jurisdiction that some promoters may consider high risk, while others may consider low. This is because Taiwan is not a member of FATF and it has a lack of accepted diplomatic status. Conversely, Taiwan continues to be a member of the Egmont Group and a member of the Asia/Pacific Group on Money Laundering (APG, which, in turn, is an associate member of FATF. The APG periodically assesses compliance by APG members with the global AML/CTF, including FATF, standards through a mutual evaluation mechanism. An APG Mutual Evaluation Report on Taiwan took place in 2007. Taiwan is due to accept the third round mutual evaluation of the APG in the second half of 2018. In accordance with Article 7 (1) of CSSF Regulation N° 12-02 of December 14, 2012 on the fight against money laundering and terrorist financing:

For the purpose of applying Articles 3-1 and 3-3 of the Law and Articles 4 and 5 of this regulation, it is for each professional to assess if a member state or a third country imposes obligations which are equivalent to those laid down in the Law or Directive 2005/60/EC, according to the particular circumstances of the case.

In adopting this approach, promoters distributing funds cross border should consider an assessment of the AML/CTF laws and regulations in Taiwan, against the standard set by the provisions of the Luxembourg AML law or the EU Directive 2005/60/EU (the “Directive”) as a benchmark, to evaluate whether the requirements in Taiwan are equivalent to the AML/CTF regulatory framework applicable to the funds. This should include regulatory supervision and the sanctions applied in cases of ML breaches. Funds should consider the establishment of periodic reporting from distributors including refreshment of due diligence files in line with standard practice.

By implementing the above control framework and tailoring their oversight over distributors, using an array of dynamic factors such as press releases, industry comment and local regulatory updates, funds will strive to define a robust, flexible and efficient process for distribution oversight, that effectively supports the business, while ensuring compliance with the demanding regulatory environment.

17 PWC Flash News, CSSF Circular 17/650 on Anti-Money Laundering and Counter-Financing of Terrorism: AML/CFT Law applied to primary tax offenses, available at: http://www.pwc.lu/en/anti-money-laundering/publications.html

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4.3 Onsite Visits to the Distributors

There may be cases where a country is deemed to be a medium/high risk, but nevertheless, funds may have a different risk assessment on their distributor in that target country and will intend to access this market. The distributors from a high-risk country will be de facto classified as high risk and hence non-equivalent. This will require thorough review of underlying investors and will increase administration. An effective oversight regime will be vital in this situation, ensuring appropriate initial and ongoing due diligence of the distributor, to establish whether the distributor applies equivalent standards to those of Luxembourg. There may be instances of countries that rely heavily on the banking industry and the financial sector, which although they have entered into conventions with the EU, have implemented the AML Directive (2005/60/CE) and issued regulations on AML/CTF transactions, did not implement an AML/CTF regulatory framework in full. Consequently, these countries may not be considered as possessing AML/CTF standards equivalent those of Luxembourg. In these circumstances, a strong oversight regime over the distribution network will enable the board to satisfy its risk appetite and manage the intrinsic risk. However, it will not be sufficient to foresee ad hoc clauses mirroring Luxembourg AML/CTF rules within the distribution agreement, but the management company will need to test and verify how the distributors processes work in practice. Compliance onsite visits in medium/high-risk countries will enhance distribution oversight and help confirm if the oversight is robust, flexible and efficient. An onsite visit is useful to perform due diligence on the implementation of the management company’s AML/CTF terrorism policy and procedures, and to assess their efficiency and effectiveness. The onsite visit will support the management company’s assessment of how the distributor ensures effective and efficient control, to identify, assess, monitor and mitigate its AML/CTF risks. Within the context of distribution oversight, an AML audit will be an essential element in the establishment of a robust, flexible and efficient process which will support the business, while ensuring compliance with a demanding and changing regulatory environment.

4.4 Cross-Border Distribution Through Platforms

Promoters should also ensure the oversight regime for platforms used to distribute funds as well as for new channels opportunities such as Fintech is effective. For the AML audit to play a key role in the oversight of these channels, it will need to consider technicalities of the distribution channel as well as understanding the differences between the various channels, in order to apply effectively a risk-based approach. Funds established in Luxembourg may still be marketed by U.S. brokers through U.S. platforms to U.S. offshore investors residing in countries, in for instance the LatAm area. The U.S. authorities provide guidance which applies only to U.S. funds for U.S. platforms streamlining the clearance and settlement of mutual fund transactions by enabling their members to transact business with hundreds of mutual fund families and thousands of mutual funds through a single, standardized process.18 However, it may be of use as a basis for establishing a solid oversight framework, to ensure that the funds on a platform are only marketed by the members, which are U.S. financial institutions submitted to the USA PATRIOT Act and equivalent AML/CTF rules. Considering that generally these platforms do not perform KYC/AML oversight over distributors, the funds will need to ensure that the KYC/AML is performed over the distributors in line with applicable local requirements. Funds must be satisfied that the KYC /AML processes of the platforms’ members are appropriate. A robust oversight framework will need to include periodic look through samples of the KYC files of the underlying clients. This will ensure a robust oversight framework. Other platforms alternatively carry out KYC/AML ongoing controls. It will therefore be important for an AML Audit to test the existence of contractual obligations, to have an adequate and effective process to ensure full compliance with all applicable AML laws or regulations. It will be crucial for an effective oversight regime to ensure the verification of the platforms AML programs and their RBA. In this context, AML audit will need to perform an

18 FinCEN, Guidance, FIN-2006-G008 available at: https://www.sec.gov/about/offices/ocie/amlmf/fin-2006-g008.pdf

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assessment of the distributors using the platform, enhancing the overall level of oversight; this will support effectively the business and manage ML/TF risks through well-designed internal controls.

4.5 Cross-Border Distribution through Fintech

Funds need to also pay attention to Fintech, which is growing rapidly and attracting significant attention from almost every market, geographically and by industry sector. Due to their lower fixed costs, improved customer experience and efficiency improvements, Fintech companies are having a significant impact on the banking and investment sphere. The most relevant Fintech macro for investment management is blockchain, which can boost the fund industry by facilitating disintermediation through greater transparency, tracking of transactions and records of assets, which will be the basis for further innovation and transformation. Blockchain technology relies on a digital and distributed ledger, which operates in a transparent environment without the need for a controlling trusted authority to validate information. The ledger contains the history of all verified transactions while multiple copies of this unique ledger are distributed to all participants across the network.19

In general, transfer agents and market infrastructure platforms have a major opportunity to develop online information services through standardized tools and highly automated processes, due to the AML/KYC data that is already present. The burden of KYC compliance could be significantly reduced through the use of a shared database of client background documentation. 20 From an AML audit perspective, the advantage of blockchain is that it is transparent and auditable, being an open source technology operated by a participants called miners. All transactions are visible and traceable within the ledger and visible on a pseudo anonymous basis.21 The major benefits of blockchain for AML/KYC are that it increases transparency, enhances compliance, and enables the sharing of a common source of data.22

5. AML/CTF Audit Program

The AML/CTF Audit Plan needs to be tailored to ensure oversight of the distribution channels and cover the different methods of distribution, taking into account a complex multi-jurisdictional distribution model. An effective AML audit on distribution oversight will need to consider among other things:

Definition of the objective of the audit, according to the priorities set by the board Background analysis including applicable legislation and regulation, jurisdiction and

documentation of the platforms used to process the transactions;

Review of the contracts and reporting in relation to distributors;

Identification of the scope of the audit including jurisdictions and platforms; Assessment of the individual risks across the distribution network, including identification of

non-equivalent jurisdictions; Identification of the expected controls to mitigate the risks; Test program based on the risk assessment, objectives and scope; Assessment of the test results, followed by identification of findings and the associated

corrective measures, with the findings graded according to their impact; Documentation of the results of the audit in a formal report to senior management, including

corrective actions to resolve any weaknesses identified; Monitoring of the resolution of corrective actions identified Follow up to ensure actions have been fully completed and formal closure

6. Benefits of an AML Audit

19 Impacts of the Blockchain on fund distribution, June 2016, Deloitte, available at: https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/technology/lu_impact-blockchain-fund-distribution.pdf 20 Blockchain application in banking , Deloitte, available at: https://www2.deloitte.com/content/dam/Deloitte/ch/Documents/innovation/ch-en-innovation-deloitte-blockchain-app-in-banking.pdf 21 Ibidem 22 Ibidem

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Defining a robust, flexible and efficient process for distribution oversight will provide comfort to the board of directors and effectively support the business, whilst simultaneously ensuring compliance with a demanding regulatory environment. An AML Audit conducted by appropriately qualified staff, functionally independent from operational staff, operating under an approved methodology, with formal working papers and processes for gathering and maintaining documentary evidence, can give the board independent assurance of the adequacy of its controls over its distribution network. It also provides the board with an independent and objective evaluation of the internal control framework and significant legislative or regulatory issues impacting the company are recognized and addressed properly and interaction with the regulator is appropriate. An AML audit will ensure a continual improvement in controls over the distribution network according to new legislation and current regulators expectations.

The AML audit will add value to the company by providing achievable and constructive recommendations identified through informed and independent assessment. It will also provide evidence to the regulator that the management company takes its responsibilities seriously and takes all necessary measures to ensure strict controls, and compliance with regulatory requirements and industry standards of best practice for AML oversight across the distribution network. Furthermore, strong controls over distribution networks confer a competitive advantage and may also be highlighted within requests for proposals (RFPs) to attract institutional business. The existence of AML/CTF audit across the network, adds credibility to the oversight and control regime, whilst simultaneously providing the board with assurances that business is being conducted in accordance with the company’s established policies and procedures, and applicable regulations.

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References PWC Anti-Money Laundering (AML) and Counter Terrorist Financing (CTF) available at: http://www.pwc.lu/en/anti-money-laundering.html PWC Flash News, CSSF Circular 17/650 on Anti-Money Laundering and Counter-Financing of Terrorism: AML/CFT Law applied to primary tax offenses, available at: http://www.pwc.lu/en/anti-money-laundering/publications.html Financial Times – Singapore shuts second Swiss bank over 1MDB corruption scandal, available at: https://www.ft.com/content/ec182626-8f64-11e6-a72e-b428cb934b78 Joint Money Laundering Steering Group Guidance –JMLSG – Prevention of money laundering / combating terrorist financing (Chapter I), November 2014 available at: http://www.jmlsg.org.uk/

Luxembourg Fund Industry Association, available at www.alfi.lu EY publication, available at: http://www.ey.com/Publication/vwLUAssets/Oct15_EY_Comment/$FILE/Oct15_EY%20Comment.pdf CSSF Regulation 12-02 available at http://www.cssf.lu/fileadmin/files/Lois_reglements/Legislation/RG_CSSF/RCSSF_No12-02eng.pdf Joint Money Laundering Steering Group Guidance –JMLSG – Prevention of money laundering / combating terrorist financing (Chapter I), November 2014 available at: http://www.jmlsg.org.uk/

Law of 17 December 2010 on undertaking for collective investments ALFI Guidelines, Practices and Recommendation aimed at reducing the risk of money laundering and terrorist financing in the Luxembourg Fund Industry, available at: http://www.alfi.lu/sites/alfi.lu/files/files/Alfi%20guidelines%20and%20recommendations/Guidelines-ABBL-ALCO-ALRIM-final.pdf Joint Money Laundering Steering Group Guidance –JMLSG – Prevention of money laundering / combating terrorist financing (Chapter II), November 2014 available at: http://www.jmlsg.org.uk/

Wolfsberg Statement – Anti-Money Laundering Guidance for Mutual Fund and Other Pooled Investment Vehicles, available at: http://www.wolfsberg-principles.com/pdf/standards/Wolfsberg_PV_Guidance_(2006).pdf CSSF Regulation N 12-02, available at: http://www.cssf.lu/en/supervision/financial-crime/aml-ctf/laws-regulations-and-other-texts/news-cat/480/

ALFI Guidelines, Practices and Recommendation aimed at reducing the risk of money laundering and terrorist financing in the Luxembourg Fund Industry, available at: http://www.alfi.lu/sites/alfi.lu/files/files/Alfi%20guidelines%20and%20recommendations/Guidelines-ABBL-ALCO-ALRIM-final.pdf

Mastering the distribution chain and related operational changes, Deloitte publications, available at: https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/financial-services/IM/lu-mastering-distribution-chain-operational-challenges.pdf CSSF Circular 12/546 available at: http://www.cssf.lu/fileadmin/files/Lois_reglements/Circulaires/Hors_blanchiment_terrorisme/cssf12_546eng_upd291215.pdf

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Mastering the distribution chain and related operational changes, Deloitte publications, available at: https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/financial-services/IM/lu-mastering-distribution-chain-operational-challenges.pdf

FinCEN, Guidance, FIN-2006-G008 available at: https://www.sec.gov/about/offices/ocie/amlmf/fin-2006-g008.pdf

Impacts of the Blockchain on fund distribution, June 2016, Deloitte, available at: https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/technology/lu_impact-blockchain-fund-distribution.pdf

Blockchain application in banking , Deloitte, available at: https://www2.deloitte.com/content/dam/Deloitte/ch/Documents/innovation/ch-en-innovation-deloitte-blockchain-app-in-banking.pdf

Glossary of acronyms: ALFI: Luxembourg Fund Industry Association APG: Asia/Pacific Group on Money Laundering AIFM: Alternative Investment Fund Manager AIFMD: Alternative Investment Fund Manager Directive AML: Anti money laundering CFT: Countering financing of terrorism CSSF: Commission de Surveillance du Secteur Financier EU: European Union FATF: Financial Action Task Force FinTech LatAm: Latin America ML/FT: Money laundering / terrorism financing RBA: Risk Based Approach UCITS: Undertaking for collective investment in transferable securities